1. International Business Economics Lecture Notes
Christos Pitelis
January 2004

2. Contents
1. Introduction: Globalisation (Nature, Evolution, Perspectives)
2. Why Multinational Corporations (MNCs) and Foreign Direct Investment (FDI)?
3. Strategy and Strategic Options of MNCs
4. MNCs, Government Policy and (Inter)national Competitiveness - Overall Conclusion and the Future of MNCs

3. International Business Economics Session 1 Introduction: ‘Globalisation’ (Nature, Evolution, Perspectives)

4. (INTERNATIONAL) COMPETITIVENESS
Exhibit 1.1: A Framework
(INTERNATIONAL) COMPETITIVENESS
FIRMS (Business, Competitive)
POLICY-
STRATEGY
GOVERNMENTS (Competition, Industrial)
THEORY

5. The Nature and Scope of International Business
International Business (IB) deals with the nature, strategy and management of international business enterprises and their effects on business and national performance (e.g., efficiency, growth, profitability, employment).
IB is interdisciplinary. It draws, among others, on economics, politics, sociology, marketing, management (human resources, strategic).

6. Some definitions (i)
FDI is the control of production which takes place in one country (‘host country’) by a firm based in another country (‘home country’). FDI is the defining feature of the multinational corporation (MNC).
Globalisation refers to the increasing integration of markets (exchange) and production, to include the mobility of resources (capital, labour, ‘organization and knowledge’).

7. Some definitions (ii)
A firm is an organisation which produces commodities for sale in the market for a profit, and allocates resources (such as capital and labour) without direct reliance on the price mechanism (the market) on the basis of internal entrepreneurial decisions (hierarchy).
An MNC is a firm which controls production in countries other than (and including) its home base.

8. Some definitions (iii)
The market (price mechanism) is an institution of resource allocation, based on voluntary exchanges (transactions) by individuals, motivated by preferences and market prices.
The state is an institution which allocates resources and influences the organization of economic activity through a legal monopoly on force.

9. Origins of IB (i)
IB is the result of the internationalisation of production and the emergence of the multinational corporations (MNCs), the subject matter of IB.
Internationalisation of production (‘globalisation’) involves international capital flows, international trade of commodities (exports-imports) and Foreign Direct Investment (FDI) by MNCs.

10. Origins of IB (ii)
Until the 1980s, there has been a tendency towards concentration of industry, and oligopolistic market structures. Firms have observed a ‘law of increasing size’ consisting of four stages:
First, the owner managed and controlled small firm (nineteenth century).
Second, the public limited ‘national’ company (limited liability, separation of ownership from management).
Third, the multidivisional (M-form) organisation (division- based), separation of strategic (long term) and operational (day-to-day) decisions.
Fourth, multinational corporations (MNCs) with production activities outside (and including) their home-base.

11. Exhibit 1.2: The unitary (U-form) firm
Chief Executive
Financial and
Accounting
Department
Personnel
Sales and
Marketing
Production
Development

12. Exhibit 1.3: A multidivisional (M-form) structure
Head Office
Central Services (e.g., Finance)
Division A
Division B
Division C
Division D
Division E
Functions
Functions
Functions
Functions
Functions

13. Exhibit 1.4: A holding company structure
Parent Company
Head Office
Company A
(wholly owned)
Company C
(90% owned)
Company E
(25% owned)
Company B
Company D
(75% owned)

14. Some facts and trends in IB (i)
International trade inside the world’s largest 350 MNCs accounts for almost 40 per cent of world merchandise trade.
The world’s largest MNCs (e.g., General Motors, Exxon, Microsoft etc) have annual sales higher than the annual gross national product (GNP) of all but around 15 nation states.
In the early 2000s in the USA, nearly half of manufacturing exports and around two thirds of imports were flowing within MNCs (intra-firm trade).

15. Some facts and trends of IB (ii)
FDI increased by over 20 per cent between 1985 and 2000, twice the growth rate of exports or output.
In the period , 63 per cent of global FDI flows was received by the developed countries (DCs) (down from almost 80% in 1989), around 33 per cent by developing countries and just over 3 per cent by Eastern European countries.
Among the developing countries, China receives the lion’s share of FDI.

16. Some facts and trends of IB (iii)
Within the DCs, the US, the UK, Canada, France and Germany are leading players.
Since 1960 the relative importance of the US and the UK as sources of outward FDI has been declining.
In the ‘Triad’ (Europe, USA, Japan), total FDI between US and the EU was almost one third of global FDI in 2000.
European FDI is largely due to M&As.
FDI declined sharply in 2001 (over 50%, the largest drop in 30 years), 2002 and 2003.

17. Some issues in IB (i)
The main issues which arise from the facts and trends of FDI concern the following:
Why international production, FDI and MNCs?
How do (should) MNCs conduct their business strategies? (competitive and corporate strategies)

18. Some issues in IB (ii)
What is the relationship between MNCs, nation states (in developed and developing countries) and international organisations and what is the impact of MNCs on growth and development?
What is the link between MNCs and international competitiveness?

19. Background 1 (pp 20-28, starts here): Firms & Industries

20. History

21. Firm integration “Strategies”
Vertical Integration (VI): Backward (raw materials) and forward (distribution).
Mergers and acquisitions (M&A): coming together of two or more firms.
Conglomerate diversification: operations-expansion of firms in ‘unrelated’ products-markets.
Foreign Direct Investment (FDI) and MNCs.
‘Hybrid’ (networks, clusters, joint ventures, strategic alliances …)

22. Main perspectives
(Market) Power: Firms pursue profit and/through (market) power.
Efficiency: Firms pursue profit through reduction of production and transaction costs.
Hybrid: Firms pursue profits through efficiency and (market) power.

23. Theories (i)
Neoclassical: Firm is ‘a production function’, a ‘black box’; it is concerned with the industry price-output ‘equilibrium’, which maximizes profits. Price-output equilibria depend on market structure, e.g., perfect competition, monopoly.
Managerial: Firms maximize utility of managers, e.g., sales revenue, growth. Based on alleged ‘separation of ownership from control’.
Transaction Costs: Firms are multi-person hierarchies which result from, and give rise to reduced market transaction costs, resulting in efficient industry structures.

24. Theories (ii)
Resource-Based: Firms are bundles of human and non-human resources under administrative co-ordination. There are internal and external stimuli to growth which lead to industry concentration.
Behavioural: Given ‘bounded rationality’ and different objectives of groups within them, firms do not maximize, they ‘satisfice’.

25. Theories (iii)
‘Austrian’ - Chicago School - Schumpeterian: Alert, profit seeking entrepreneurs, enhance market co-ordination and give rise to ephemeral monopoly profits, eroded through competitive process of ‘creative destruction’ (innovations).
‘Marxist’: Firms produce commodities for sale in the market for a profit, under hierarchical control of capital over labour. Dialectic link between competition and monopoly, for maintenance of monopoly (power).

26. Some critical elements for economic analysis (DISCO) (i)
Demand (D): The demand conditions firms face, in the form of a Demand Curve, derived from ‘Theory of Demand’.
Industry Structure (IS): The extent of industry concentration, barriers to entry, etc, leading to competitive, imperfectly competitive, oligopolistic, or monopolistic industry structures.

27. Some critical elements for economic analysis (DISCO) (ii)
Costs (C): The cost conditions faced by the firm, in the shape of a Cost Curve, derived from ‘Theory of Production and Costs’.
Objectives (O): The firms’ aim. It allows the derivation of price-output ‘equilibria’. Usual assumption is profit maximization (Marginal Cost equals Marginal Revenue). Others are maximization of sales revenue or growth. Alternatives are ‘satisficing’, ‘entrepreneuring’…

28. Exhibit 1.5: Monopoly versus Competition
, minimum efficient scale
PM monopoly price
PC perfect competition price PM
LAC = LMC PC D Q QM QC Q
[End of Background 1] MR

29. ‘Globalization’: causes
Firm growth because of
Use of excess internal resources at near zero marginal cost
Sale of products to new markets at high profit rates (due to high fixed costs).

30. ‘Globalization’: facilitators
Reductions in transportation costs.
Improvements in information and communication technologies.

31. International Business Economics Session 2 Why MNCs and FDI?

32. The Multinational Corporation (MNC)
Definition
MNC = firm which controls production across national boundaries through intra-firm (non-market) operations.
Question
Why MNCs as opposed to exports, franchising, licensing, etc. ?

33. Background 2 (pp 32-65, starts here): Perspectives on the theory of firm

34. The Neoclassical analysis (i)
Simple Market Structure Analysis (Perfect Competition vs Monopoly)
Perfect Competition defined: Market structure characterised by a large number of profit maximising buyers and sellers selling homogeneous products, and no entry barriers.
Result: Price taking behaviour, price at minimum long run average cost (LAC) curve Þ ‘normal’ profits.

35. The Neoclassical analysis (ii)
Monopoly defined: market structure characterised by a single profit maximising producer and very high entry barriers (no entry).
Result: monopoly prices exceeding minimum LAC Þ ‘Excess’ (monopoly) profits.
Conclusion: departures from perfect competition result in increases in prices and reductions in output. Also to ‘welfare losses’ due to ‘monopoly power’.

36. The Neoclassical analysis (iii) - Oligopoly
Defined: market structure characterised by interdependence of (usually a small number of) producers-firms. Duopoly is the case of two firms.

37. Exhibit 5: Industrial Organisation (IO) and the S(tructure) - C(onduct) - P(erformance) model
IO Defined: Branch of economic theory analysing structure-conduct and performance (SCP) of oligopolistic industries (set of firms producing similar products).
SCP Model: Suggests there exists a (initially unidirectional) link between structure (S), conduct (C) and performance (P) of industries. Feedback relationships from conduct and/or performance to structure later allowed for.
Main Focus: The concentration (S) - Profitability (P) relationship assuming profit maximisation (C).
‘New IO’ analyses impact of conduct on structure and performance in oligopolistic games.

38. Theoretical specification of industry structures
1. Limit pricing
2. Unconstrained profit maximizing oligopoly
3. Contestable markets

39. 1. Limit Pricing
Assumes constrained profit maximisation (maximum profits subject to no entry), barriers to entry (minimum efficiency scale) and that incumbents leave post-entry output at pre-entry levels and entrants know this.
Result: Limit price derives from limit output found by subtracting the minimum efficient scale level of output from the perfect competition level.

40. Exhibit 2.1: Derivation of the limit pricePL PC QL Q QC D
LAC Q Q
PL is determined by QL, i.e. the level to which, if the MES was added, the competitive output would result, thus PC, thus no ENTRY.
RULE:

41. 2. Unconstrained profit maximising oligopoly
Assumes blockaded entry and joint profit maximising price-output levels (Monopoly). Entry is blockaded through strategic entry barriers, e.g., investment in excess capacity.

42. 3. Contestable markets
Assume free entry and costless exit. This ensures perfectly competitive price-output levels, even in the presence of economies of scale and oligopolistic market structures, as any departures from perfectly competitive prices lead to hit-and-run entry and exit.

43. IO models compared
Main issue is the nature and importance of entry barriers, both ‘innocent’/structural (scale economies) and strategic (conscious actions by incumbents designed to deter entry), e.g., excess capacity, product proliferation.
Well analysed strategic entry deterrence strategy, the investment in ‘excess capacity’. In the limit even monopoly pricing is sustainable if incumbents have excess capacity sufficient to produce full perfect competition output. To be credible, excess capacity investment should be optimal post-entry.

44. Exhibit 2.2: An expository diagrammatic framework to Industrial OrganisationPM PL PC
LAC = LMC QM MR QS D QL QC Q
, minimum efficient scale
QS, strategic capacity output
PM monopoly price
PL limit price
PC perfect competition price Q

45. Firm-industry structures and business strategy
Oligopoly, crucial for (competitive) strategy, which is absent in cases of both perfect competition and monopoly. Emergence and effects of oligopoly analysed by theory of Industrial Organization (IO), which is based on and extends the Cournot/Bertrand models of oligopoly.
M-Form organisation is important condition for development of corporate strategy (existence of multitude of business units).

46. Theory of Firms & Industries: Alternative Perspectives
Transaction Costs, Markets and Hierarchies
Resource-Based and related perspectives

47. Transaction Costs, Markets & Hierarchies (i)
Origin: Coase (1937)
Assumptions
i) Market is ‘original’ means of resource allocation =>
ii) Existence of hierarchies (e.g., firms) due to market failure
Nature of market failure
Cognitive (natural) not structural; i.e., due to transaction costs and not monopoly power.

48. Transaction Costs, Markets & Hierarchies (ii)
(Market) Transaction Costs are costs of information, bargaining, contracting, policing and enforcing agreements.
Main Proposition (Coase, Williamson, etc.):
internalization of markets by hierarchies, i.e., replacement of voluntary exchanges with hierarchy => savings in transaction costs => hierarchy (firm) more efficient way to allocate resources.
Horizontal and vertical integration, the M-form, and conglomeration result from pursuit of transaction cost reductions.

49. Transaction Costs, Markets & Hierarchies (iii)
Policy Implications
In neoclassical approach departures from perfect competition => market failure (structural) => => need for government intervention.
In transaction costs approach hierarchies (including M-form conglomerates and MNCs) =
efficiency improving solutions to (natural) market failure => => less need to interfere with the markets.

50. Resource-based & related perspectives (i)
Early work by Penrose (1959)
Firm = “a collection of resources bound together in an administrative framework, the boundaries of which are determined by the ‘area of administrative co-ordination and authorative communication’” (Penrose, 1995, p xi).
Focus on ‘the internal resources of the firm’, then the external environment. Latter is different for each firm depending ‘on its specific collection of human and other resources’. Environment can be manipulated by firms to serve their objectives.

51. Resource-based & related perspectives (ii)
Dynamic interaction between internal and perceived external environment (‘image’, and ‘productive opportunity’).
Endogenous Growth, results from
i) resource indivisibility,
ii) knowledge creation within firms, which releases resources.
A firm’s prospects are in terms of existing and new products; diversification as new markets become relatively more attractive than existing ones.

52. Resource-based & related perspectives (iii)
Knowledge is tacit.
‘History matters’, growth is an evolutionary process, based on cumulative growth of collective knowledge in the context of a purposeful firm.
Rate of firm’s growth limited by growth of knowledge within it, and a firm’s size by the extend to which administrative effectiveness continues to reach expanding boundaries.

53. Resource-based & related perspectives (iv)
Firm strategies result of differential capability, e.g.,
Vertical Integration, due to ability of firms to serve their own needs better.
Diversification, due to growth and multiple applicability of resources.
Mergers and Acquisitions; to acquire managerial resources for expansion.
MNCs, due to differential ability e.g., in transferring tacit knowledge (Kogut-Zander).

54. Resource-based & related perspectives (v) (Nelson & Winter, 1982)
In Nelson and Winter’s evolutionary theory of the firm, routines, search (changes in routines) and competition are economic analogues to genes, heredity and struggle for existence in biology.

55. Resource-based & related perspectives (vi) (Capabilities-based)
Use and develop hard to imitate and costly to apply internal capabilities.
Rents in equilibrium.

56. Resource-based & related perspectives (viii) (knowledge-based theories, Penrose, etc.)
Firms better than markets in using, preserving, transferring and developing knowledge.
Value creation – growth through knowledge and value appropriation.

57. Resource-based & related perspectives (ix) (Richardson and co-operation)
“Dense network of co-operation and affiliation by which firms are inter-related.”
Markets, hierarchy and networks are a function of degree of complementarity and similarity of activities
weakly complementary activities => MARKET
complementary and similar activities => HIERARCHY
complementary and dissimilar activities => CO-OPERATION
[End of Background 2}

58. Theories of the MNC Two main types: Supply-side theories. Mainly
- Demand-side
- Other factors – “theories”
Supply-side theories. Mainly
- Monopolistic – ‘ownership’ advantage
- Transaction costs and internalisation
- Eclectic theory (or Ownership, Location, Internalisation - OLI paradigm)
- Divide and rule
- Resource-based

59. Supply-side theories: Monopolistic ‘ownership’ advantage (i)
Origin: Hymer’s 1960 PhD thesis
Assume: ‘Law of increasing firm size’: Firms growth leads to concentration and acquisition of monopolistic advantages (MAs).
Firms’ pursuit of (monopoly) profit => seeking overseas markets.
MAs allow firms to outcompete foreign rivals.
MNCs aim at reducing conflict.

60. Supply-side theories: Monopolistic ‘ownership’ advantage (ii)
Choice of FDI over market-based alternatives due to control potential and oligopolistic interaction.
Collusion allows reduction of conflict and maintenance of monopoly profits.
Conclude: Structural market failure => MNCs => (international) structural market failure

61. Supply-side theories: Transaction costs - internalization (i)
Existence of firms => Economising in transaction costs => Firms more efficient than markets
In case of MNCs, choice is between market transactions, e.g., exporting, licensing and non-market transactions, i.e. Foreign Direct Investment (FDI).

62. Supply-side theories: Transaction costs - internalization (ii)
Reasons for FDI
Williamson: asset specificity => hold-up problems => need for fully owned subsidiaries (FDI).
Buckley & Casson: intangible assets exhibit ‘public goods’ attributes, thus result in appropriability problems => market failure.
Hennart: internalization of markets due to differential ability to control (overseas) labour.

63. Supply-side theories: Transaction costs - internalization (iii)
Conclusion
Internalization of markets through MNCs are efficient solution to intrinsic (transaction costs-related) market failure.

64. Supply-side theories: Eclectic theory (or ‘OLI paradigm’)
Dunning, combined a and b as well as location advantages to provide ‘eclectic theory’ or O(ownership), L(ocation), I(nternalization) paradigm.
OLI explains internationalization of production, not the MNC.
O explains why firms are able to become MNCs.
I explains why they benefit from internalizing markets or advantages.
L explains the choice of location.

65. Supply-side theories: Divide and Rule (Sugden)
Builds on Marglin-Hymer
Focuses on labour markets. He suggests that a reason for MNCs is their ability to divide labour (unions) in country specific groups => Reduce their bargaining power => increase their profits.

66. Supply-side theories: Resource-based (Penrose, Teece, Kogut-Zander)
MNCs are due to endogenous growth and differential capabilities vis-à-vis market and other firms.
Growth can be national (diversification) or geographical (MNC).
MNCs are better in transferring internationally tacit knowledge than markets.

67. Demand-side theory (i)
Cowling & Sugden, Pitelis: increased concentration => increased profits => reduced consumers expenditure (because a lower proportion of profit is consumed than of wage income).
As consumption decreases so does effective demand => going overseas for demand outlets.

68. Demand-side theory (ii)
The MNC as an All Weather Company
Diversified national firms can ride the industry life cycle (Hymer).
MNCs can ride the national business cycle, becoming All Weather Companies.

69. Other factors – ‘theories’
Oligopolistic rivalry
Present in most theories (except transaction costs).
Can motivate - shape firms’ payoff matrix => crucial context within which decisions are taken.
Specifically oligopolistic interaction theories (e.g., Graham), build on Hymer and emphasize role of threats and counter-threats.
Competition between states
Nation states may promote their own MNCs to affect their international competitiveness – could explain some LDC MNCs.

70. Synthesis (i) Context: Oligopolistic interaction
Endogenous growth (Penrose) => monopolistic advantages (Hymer).
MAs are an inducement to innovation and further growth (Penrose); they can help firms outcompete foreign rivals (Hymer).
Domestic diversification due to pull factors, e.g., multiple use of resources (Penrose), or push factors, e.g., the product life cycle (Hymer).

71. Synthesis (ii)
Geographical diversification also due to national-regional business cycles (all weather company).
Mode of expansion due to differential firm capabilities (Penrose, Teece, Kogut & Zander), (dynamic) transaction costs (Teece, Buckley & Casson) and overall control advantages (Hymer).
Locational factors explain the choice of location.
No general theory possible, but a general framework within which each case can be examined.

72. MNCs impact on welfare
Monopolistic advantage theory => possibility of reduced competition due to MNCs => (Pareto) inefficiency á
Internalization hypothesis => transaction reductions => efficiency.
Eclectic view => advantages and disadvantages => ‘trade-off’.
Divide and rule hypothesis => reduced workers welfare => (Pareto) inefficiency.
Resource-based => efficiency and inefficiency may co-exist
Synthesis => coexistence of efficiency and power => ‘trade-off’.

73. The MNC and ‘Uneven Development’(Hymer)
For Hymer (1972), the operations of MNCs tend to globalize the tendency towards concentration; generate an uneven development between the centre (developed countries) and the periphery (less developed countries); erode the power of labour unions and the nation state, and tend to shape the world to their image by creating ‘superior’ and ‘inferior’ countries. They are responsible for the dependent industrialization of the Newly Industrialized Countries.

74. International Business Economics Session 3 Strategy and Strategic Options of MNCs

75. Background 3 (pp 83-99, starts here) Business Strategy

76. Business Strategy (i) Firms’ evolution – strategies
Horizontal integration (mergers and acquisitions)
Vertical integration (backward and forward)
Multidivisional (M-) form (business units under central control)
Conglomeration (unrelated business activities)
Foreign Direct Investment - multinational corporations (foreign direct investment)
Networks, alliances clusters, joint ventures, etc.
All such strategies involve future cash flows, thus require ‘capital budgeting’.

77. Business Strategy (ii)
Types of strategy
Competitive: Strategy of Business Units
Corporate: Strategy of firm as a whole

78. Competitive Strategy Porter: based on IO
‘Five forces’ model (rivalry of existing competitors, potential entrants, power of suppliers-buyers, substitute products).
Rule: select and/or create ‘attractive industries’ (with weak forces of competition)
Three generic competitive strategies (cost leadership, differentiation, focus).
Rule: do not get stuck in the middle.

79. Exhibit 3.1: M. Porter’s five forces model

80. Exhibit 3.2: M. Porter’s three generic strategies

81. Competitive Strategy Porter (cont’d)
Value chains: firm’s primary and support activities that generate value (margin)
primary: firm infrastructure, human resource management, technology development, procurement
support: inbound logistics, operations, outbound logistics, marketing and sales, service
Rule: align value chain to generic strategy

82. Exhibit 3.3: M. Porter’s value chain

83. Corporate Strategy Portfolio models - Boston Consulting Group, etc.
Porter
Resources-capabilities

84. Corporate Strategy: Portfolio models - The Boston Consulting Group (i)
Learning and experience gives rise to reduced unit costs as volume increases
Market share increases profitability
Portfolio matrix: to classify business units as stars, cash cows, question marks and dogs on the basis of industry growth rates and business units’ relative market share
Rule: cash-in cash cows, to invest in stars and selected question marks, stars-to-be. Liquidate dogs.

85. Corporate Strategy: Portfolio models- The Boston Consulting Group (ii)
BCG matrix related to the industry product life cycle (introduction-question marks, growth-stars, maturity/saturation-cash cows, decline-dogs).
Portfolio Models: Shell, General Electric
same principle as BCG, different criteria and classifications

86. Exhibit 3.4: The experience curve

87. Exhibit 3.5: The BCG growth/share business portfolio matrix

88. Exhibit 3.6: The life cycle model

89. Exhibit 3.7: The product life cycle and the Boston matrix

90. Corporate strategy: The approach of M. Porter
Four types of corporate strategy
portfolio management (as in BCG matrix)
restructuring (restructure and sell-off)
transfer of skills
sharing activities
Rule: select sharing activities or, if not possible, transfer of skills. Other two hard to implement with success.

91. Corporate Strategy: The resources – capabilities perspective (Penrose, Teece, etc.)
Diversification strategies are the result of availability of resources with potential for common use by apparently unrelated activities.
Conglomerate diversification results from problem of appropriating rents from intangible assets and/or differential capabilities in transferring knowledge.
[End of Background 3]

92. Strategy of MNCs (i) For Michael Porter industries are
multidomestic (nationally responsive), requiring locally focused strategy
global (linked, integrated), requiring integrated strategy

93. Strategy of MNCs (ii)
For Bartlett and Ghoshal: four basic strategies emerge on the basis of cost pressures – local responsiveness matrix:
international (low, low)
multidomestic (low, high)
global (high, low)
transnational (high, high)

94. Exhibit 3.2: Bartlett and Ghoshal’s Options for MNCs
High
Global
Transnational
Cost
Pressures
Low
International
Multidomestic
Local
Responsiveness

95. Exhibit 3.9: A summary of theory and strategy

96. Application: A simple decision framework
Transport costs and tariffs
Low
Export
High
Suitability of know-how for licensing No
Horizontal FDI
Yes
Foreign operation requires tight control
Yes
Horizontal FDI No
Know-how can be protected by licensing contract No
Horizontal FDI
Yes
Based on C. Hill (2003)
Licence

97. International Business Economics Session 4 MNCs, Government Policy and (Inter)national Competitiveness

98. Competitiveness: definition
Differential productivity, value-added – wealth creation, relative to other economic units (firms, regions, nations…)
Can be achieved through
Business policies
Government (competition, industrial and competitiveness) policies

99. Competition and Industrial Policy
Early competition-industrial policies in West derive from IO theory, in particular the issue of the welfare effects of monopoly (power). This includes analysis of
i) Static effects (monopoly and reduced consumer welfare, due to high prices);
ii) Dynamic effects (e.g., monopoly and innovation).

100. Monopoly & international competitiveness (i)
Main claim that large firms can exploit economies of scale and scope, therefore can compete with large firms from other countries.
Idea particularly prevalent is 1960s and 1970s in Europe, in part as response to the ‘American Challenge’, e.g., Servan-Schreiber’s claim that US multinational corporations dominate technologically European markets.
If large size increases competitiveness (thus export surpluses) these could offset any static losses.
The international competitiveness idea is in part responsible for the permissive (and even encouraging) attitude of European countries to mergers and large size.

101. Monopoly & international competitiveness (ii)
Counter arguments are:
i) higher X-inefficiency
ii) may suppress major inventions if they result in major re-equipment
iii) inflexibility
Schumpeter’s ‘Differential Innovations Hypothesis’, that large firms are large because they have been more successful innovators to start with.

102. Monopoly and Welfare Conclude
An open question whether the dynamic gains offset the static losses. Evidence inconclusive.
Focus on efficient resource allocation limited. Concentrate on resource creation?

103. Practice – The Western approach
Theoretical Basis
i) ‘Competition policy’ to correct market failure due to monopoly (power) and its abuse: e.g., Treaty of Rome, US Anti-Trust policies
ii) Trade through (static) comparative advantage, lenient or encouraging attitude to multinational corporations (MNCs)

104. Practice – The Western approach (EU) (i)
But in 1960s
‘Recognition’ in Europe of the ‘international competitiveness’ advantages of ‘large size’ (American challenge thesis)
Relatedly,
‘National Champions Policy’ (e.g., UK, France, Italy)
Nationalizations of ‘strategic’ sectors
1970s
‘Lame Ducks’ policies

105. Practice – The Western approach (EU) (ii)
Return to the market (privatisations etc) and focus on ‘Government Failure’.
1990s
Entrepreneurship and small firms
Horizontal measures, technology and education, tangible and intangible infrastructure, efficiency of public sector.

106. Practice – The Western approach (USA)
Hidden industrial policy in the form of defence policy?
revival of 1990s; clusters?
Conclude
‘Grant Theory’ but no industrial strategy including adhocity, discontinuity, undue focus on (dis)advantages of size and static comparative advantage-based (free) trade.

107. Practice – The Far Eastern approach (Japan)
Basis: Industrial Strategy by Ministry of Trade & Industry (MITI) involving:
i) Dynamic comparative advantage (created comparative advantage).
ii) Managed trade, with initial focus on internal competition.
iii) Management of competition (the ‘Golden Mean’) and co-operation.
iv) Dynamic competition through innovativeness, as in Schumpeter - Hayek.

108. Practice – The Four Tigers (Singapore, Taiwan, South Korea, Hong Kong) (i)
Basis: Similar to Japan, adaptive industrial strategy involving
i) Import substitution.
ii) Export promotion based on labour intensive manufacturing.
iii) Promotion of high technology/high value added sectors.
iv) Attraction of FDI (Singapore, Taiwan), technology transfer.

109. Practice – The Four Tigers (Singapore, Taiwan, South Korea, Hong Kong) (ii)
Relative success of ‘Far East’
Result of multitude of complex factors which include culture, high saving, effective public administration, close relation between industry and finance, consensus, new (strategic) management techniques, etc.
Question: Can we exclude role of industrial strategy? Is it unrelated to the other factors?

110. New theories ‘New Trade Theory’ ‘New Competition’
New location economics
New (‘Endogenous’) Growth Theory
MNCs, deindustrialisdation and ‘Competitive Bidding’

111. 1. New trade theory (i)
Traditional focus of Western industrial policy, the welfare effects of monopoly and the theory of (static) comparative advantage. According to this countries should specialize and trade in products in which they enjoy a comparative advantage. Benefits from trade arise when each country pursues such a strategy.
Presence of monopolistic competition, economies of scale, positive externalities and first mover advantages led to conclusion that focus on high return industries can affect the distribution of benefits (and even lead to losses, Krugman) – Strategic Trade.

112. 1. New trade theory (ii)
This led to concept of dynamic comparative advantage; i.e., attempts by countries to create (not accept the existing) comparative advantages.
Best known case of dynamic comparative advantage policy is Japan.

113. 2. The New Competition (i)
Based on observation of successful industrial districts, in North Italy, Germany, USA, Cambridge UK, etc.
Such districts consist of small and medium sized, highly innovative, customer oriented firms, with a hands-on approach to management, which cooperate on issues of infrastructure, technology etc and compete in the market for customers. Often rely on support by state/local authorities, are based more on trust than hierarchical relations, try to ‘exploit’ the dispersed knowledge of their labour, suppliers etc and use new production methods such as Just-in-Time, etc.

114. 2. The New Competition (ii)
Success of industrial districts questions benefits of large size and provides a different (“Post-Fordist”) model of industrial development. However, such methods are also adopted by major, particularly Japanese, MNCs, through e.g., subcontracting.

115. 3. New Location Economics (Krugman, Porter)
Importance of location in generating external economies, reducing transaction costs through trust, and further innovation.

116. 4. New Endogenous Growth Theory (Lucas, Romer)
Importance of human resources and technological change in effecting (‘endogenous’) macroeconomic growth.

117. 5. MNCs, Deindustrialization and Competitive Bidding
Link between multinational corporations and deindustrialization questions link between large size and international competitiveness
Main idea is that countries like the UK which suffer from deindustrialization tendencies are home bases of privately successful MNCs. This questions the benefits of large size for the case of MNCs home base.
In era of multinational corporations ‘name of the game’ that of ‘competitive bidding’, i.e., attempt by governments to attract investments by home and foreign firms (MNCs).

118. Theory and Practice
Question: New approaches support/explain ‘Far Eastern’ miracle?
‘New Industrial Strategy for Democracy’ (Cowling & Sugden)
MNCs give rise to multinationalism, centipetalism and short termism. Needed is a shift of power to communities and regions, e.g., through appropriate ‘flexible specialization’ policies.

119. Preliminary Conclusion
Possibility for Machiavellian scenario i.e., adaptive industrial strategy (in partnership with corporate sector) including
i) dynamic comparative advantage
ii) managed competition and co-operation
iii) managed trade
iv) playing the ‘competitive bidding game’ and/or
v) tackling the challenge of MNCs
vi) considering alternative forms of competitiveness, like ‘flexible specialization’

120. Developing countries
Some common features: small internal size of market, lack of large ‘national’ MNC’s (over-) reliance on small family run businesses, and foreign MNCs, relatively underdeveloped industry.
Possible Strategy:
i) follow the ‘four tigers’ and
ii) consider ‘appropriate’ focus on small and medium sized enterprise, flexible specialization, clustering.
Main issue: selection, suitability, transferability and feasibility of policies.

121. The Importance of Institutions (i)
Main problem of implementation, ‘government failure’. Although a general problem, often more acute in developing countries. Indeed underdevelopment may be the effect of inefficient property rights, and incentive mechanisms? (North)
Culture, consensus, other institutional constraints.
Need for promoting an institutional framework conducive to development. This includes addressing the problem of ‘capture’ of the state by MNCs.

122. The Importance of Institutions (ii)
Government can be enabling (reduce private sector transaction and production costs) to increase output. It can also be developmental, i.e., try to improve the revenue side.
Analysis of the state suggests that problem of ‘capture’ reduced through pluralism of institutional forms (large and small firms) and competition in the political market.
‘Capture’ effects support a competitiveness strategy favouring smaller firms (potential competition to established giants).

123. Conclusions (i)
Possible and necessary to devise a competitiveness strategy which learns from economic theory and international practice and addresses the issue of implementation (e.g., institutions and ‘capture’ of the ‘state’) and for the EU its declared needs to promote Competition and Convergence

124. Conclusions (ii)
Developing countries should consider their policies in the above framework, striving for an emphasis on dynamic competition, value creation and supply-side convergence. Internally they should address the issue of the institutional constraints.
Identification and development of distinct capabilities and competencies of a nation and governments important condition for effective, implementable strategy.

125. ‘Anti-trust’ today: some problems
Potential problems with current policies
i) Downplay lessons from the ‘Far East’ and the ‘new approaches’.
ii) Do not address the problem of MNCs (as a potential threat to competition).
iii) Ignore distribution issues, intra-EU and between EU and ‘The South’, which undermines sustainability.
iv) Fail to provide supply-side incentives for convergence.
v) Fail to distinguish between policies that re-distribute resources and policies that generate resources.
Need to move from competition to competitiveness policies

126. From competition to competitiveness policies: models of competitiveness
Neoclassical model
Competitive markets
Free trade
‘Japanese’
Porter’s ‘Diamond’
Productivity-Competitiveness Wheel

127. Exhibit 4.1: Competitiveness – the neoclassical modelPm PL PC
LAC1 = LMC1
LAC2 = LMC2 Qm Q MR QS D QL QC
A common expository diagrammatic framework for neo-classical Austrian and Marxist approaches to industrial organization. Q
, minimum efficient scale; QS, strategic capacity output, p, monopolist’s disincentive to invent; E, efficiency gains; Pm monopoly price; PL limit price; PC perfect competition price

128. Competitiveness (i) The ‘Japanese’ approach ?
High knowledge intensive sectors

129. Exhibit 4.2: Competitiveness – the Japanese approach?
Knowledge-intensive industries (computers, instruments, heavy machinery)
Medium capital-and labour-intensive industries (light machinery, motor cars)
Medium capital- and raw-material-intensive industries (Steel, plastics, fibers)
Unskilled-labour-intensive industries
100%
West Germany (1974)
Japan (1985)
Japan (1974)
Japan (1959)
Source: Best (1990)

130. Competitiveness (ii) Porter’s ‘diamond’
Factor and demand conditions, clusters

131. Exhibit 4.3: The determinants of national competitive advantage (Porter’s ‘Diamond’)
STRATEGY STRUCTURE AND RIVALRY
FACTOR CONDITIONS
DEMAND CONDITIONS
RELATED AND SUPPORTING INDUSTRIES

132. Problems with existing models
Absence of commonly agreed upon conceptual framework.
Absence of links between competitiveness at the firm-regional and national levels.
Insufficient analysis of determinants of productivity and competitiveness.
Insufficient treatment of the issue of sustainability.

133. Sustainable Competitiveness and Development: a conceptual framework
The Productivity-Competitiveness Model
Competitiveness <=> Productivity - Value Creation
Determinants of Productivity - Value
Firm level
infrastructure
human resources
technology and innovation
unit costs economies
Regional and National levels: As above plus
Industry structure - conduct and regional - locational milieu
macroeconomic environment - policy mix
institutional environment - governance mix

134. “The Productivity - Competitiveness - Wheel” for Firms, Regions and Nations

135. Main routes to competitiveness
Firm size & FDI by MNCs
Clusters of Small and Medium-Sized Enterprises (SMEs)

136. What are Clusters?
(Geographical) agglomerations of firms (and other organizations-institutions) linked horizontally (and/or vertically) intra- (and/or inter-) sectorally, in a facilitatory socio-institutional and cultural milieu, which compete & co-operate (co-opete) in (inter)national markets.

137. Clusters and the Wheel Clusters => innovation
reduced unit cost economies (economies of scale, scope, transaction costs, learning, external, diversity, etc.)
better human resources
strong regional infrastructure
more facilitatory institutional context (through co-opetition, etc.)

138. Despite problems, clusters are important
Clusters improve innovation, productivity & competitiveness at the regional & national levels, they create employment and can lead to convergence.
Clusters are more bottom-up, thus help deepen democracy.
Problems include identifying nature, boundaries, strategies for sustained successful performance.

139. Foreign Direct Investment and Clusters
Large firms and (through) foreign direct investment (FDI) can improve determinants of productivity, yet:
Hard for developing countries to attract FDI
Risk of FDI flight, given options, and flexibility of operations
Clusters have advantage over large firms and FDI because of local base and co-opetitive nature.
Clusters attract FDI and embed it in localities.

140. Three agents of productivity, value and wealth creation
Large firms, FDI
SMEs, Clusters
Government
Institutional context -
Governance mix
Macroeconomic environment -
Policy mix - Effective demand
Productivity-Value-
Wealth
Unit Cost
Economies
Technology &
Innovativeness
Human
Resources
(Infra)structure & Strategy
Industry conduct – structure and
regional-
locational milieu

141. Cluster Creation versus Cluster Development
Clusters are mainly the result of history, and (thus) are hard to create ‘top-down’.
However, theory and international experience suggest that cluster development can be facilitated
Clusters can be upgraded at the individual, regional or national levels.
This presupposes cluster identification, (diagnosis), audit, upgrading, control-evaluation, re-diagnosis…

142. Strategy for Sustainable Competitiveness
According to the Productivity-Competitiveness model all the following measures can improve productivity and competitiveness
horizontal measures (soft and hard infrastructure)
inter- and intra-firm sectoral restructuring for innovative ‘value for money’ products and services
clusters of SMEs
‘Regions of Excellence’ (‘mega-clusters’) can encapsulate all three aspects, thus serve as Strategy for Productivity and Competitiveness.

143. Prerequisites and Mechanisms
Sustainability requires
macro-policy - supply-side compatible
institutional framework – remove (anti)incentives
competition policy co-opetition for innovativeness
environment
distribution of income

144. Conclusions
Possible and desirable to identify and develop (mega) clusters, for productivity, competitiveness, regional development, convergence and deepening of democracy.
The state can be a catalyst and facilitator.
Method and tools developed can help in this direction.

145. International Business Economics Overall Conclusion and the Future of MNCs

146. Conclusions Value creation, through
firm productivity and competitiveness
government enabling policies, national productivity and competitiveness
Under conditions, MNCs and FDI, SME clusters and government policy can help achieve this objective

147. The Future
The MNC, like ‘competition’ and co-operation itself, is both ‘god and devil’.
MNCs will be a great force of economic growth, yet a threat to diversity, equity and democracy.
Policy and polity should aim at identifying routes that deliver the goods at least cost – this can include painful ‘trade-offs’.